Legacy Matters: Finding the Right Home for Your Business

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In the world of business, not all deals are what they seem.

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Fortunes rise, empires crumble, all with the stroke of a pen Mergers, acquisitions, hostile takeovers.

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Welcome to Mergers, she Wrote, where we examine strategies and stories behind the biggest deals in business, because in M&A, the real risks are the ones you don't take.

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Welcome to Merger, she Wrote.

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I have a great guest today, kazem Harfouch, who's the managing partner of Cedar Crest Capital.

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On our episode today we talk about how to prepare your business for sale well in advance of the actual exit, how earnouts could impact the purchase price and what makes Cedar Crest Capital different than private equity.

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Thank you so much for being on today.

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Thank you for having me.

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I'm excited.

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I'm excited too.

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Inaugural episode of Merger.

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She Wrote so big thank you for you for being on today.

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generally, Please go easy with the questions.

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So I think we'll just start today with a little bit about what is Cedar Crest Capital?

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Tell me a little bit about its origin story.

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Okay, I'm going to tell you the full story, since we have time, I won't bore you out though.

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My parents are immigrants, came here a long time ago.

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Like most immigrants, they don't really want to work for anybody else.

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Uh, my dad scrapped up some cash, he bought a small business and he ran that himself.

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And growing up as a kid I was exposed to that and I was like, yeah, this is pretty interesting.

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You know, do I want to be a doctor?

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Do I want to go be a lawyer?

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Uh, do I want to go into business?

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And uh, I was pretty much hooked.

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And in high school I googled how do I become an investor?

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And Google at the time said you got to go do investment banking for a couple of years and then from there, private equity recruits you and that's the path.

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So great, that's what we're going to do.

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I left high school with two years of college done, all transferred over here locally ASU U of A.

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I figured you know what?

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Let's just stay close to the family, let's go to ASU.

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They had a banking program there called IBIS, which is an amazing program that was very fortunate enough to get into as a freshman.

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You know they take about 13 students out of ASU and they basically train you to become an investment banking analyst.

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And at the same time, my dad started having operational issues with his business that he had no clue how to deal with, started having operational issues with his business that he had no clue how to deal with, and I realized you know what Investing in banking will definitely get me to where I want to go, but it's not going to teach me the ins and outs of business, of what actually happens in a company.

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How do companies fail, how do you turn them around?

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How do you fix them?

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And I did a full pivot.

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I decided to do consulting.

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So I went to New York City after college.

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I worked for one of the big consulting firms and my clients were private equity clients, so it was with them, with the mega funds, and my role there was to do operational due diligence.

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So before they bought a business, we would come in and we would essentially look at okay, from an operational standpoint, what savings could we generate, which unfortunately is unfortunately is a fancy way of saying who can we fire, and it was very uncomfortable for me doing that, but at the end of the day, it's what we had to do, what we were hired to do.

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After doing that for about three years, I was like you know what?

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I want to go to the other side now.

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I want to be on the investing side and I got recruited to join the Najafi companies out here in Phoenix, picked up my bags, moved back to Arizona, joined a fascinating team and was with them for about four years, and while I was there I realized the whole world is so focused on AI technology, e-commerce, digital.

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I'm not smart enough to keep up with the change in technology.

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Every six months it's changing and we're not going to be able to compete against Facebook, amazon, Google, the world.

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So we decided to spin out and form Cedar Crest Capital because we realized there's a huge gap in the marketplace.

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There's all these amazing businesses in this country that are too small for private equity and we define that as sub 3 million of EBITDA, don't use technology, have been around for decades 10, 20, 30, 40 years and the kids don't want to take them over because they're not cool enough for the kids.

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So you have all these amazing businesses where they need a permanent home.

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They need somebody to step in and purchase them and keep the legacies alive.

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So that's what we do and what we focus on.

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We focus on a very small subset of deals in this country and I think it's a gap that is missing and we're hoping to fill that.

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Absolutely so.

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When you're targeting the acquisition of businesses in this gap per se, is it across the United States?

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Is it outside of the United States?

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Is it more local?

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So when we first started, it was pretty much Arizona and neighboring states.

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We started seeing so many interesting opportunities Florida, you know, northeast, northwest, all over the place and we realized the gap there was.

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We don't have operating partners in those states to actually run them.

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So businesses of this size, half of the time the seller is fairly involved, half of the time they have a team in place.

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For the ones where the seller is involved, we have to replace what they do.

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So we were passing on businesses left and right just because we don't have anybody in that market to run them, and it was hurting me because these are very interesting businesses.

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So what we ended up doing was we started reaching out to search funds, because search funds are out there looking for deals every single day and they may have not done this before or they might not have the capital to do it.

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So we say you know what?

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Let's partner up, bring us the opportunity, we'll buy it with you, you'll co-invest with us, you step in to run the business.

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And that post went viral.

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We interviewed close to 250 people.

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So now we have almost three plus operating partners in every single state.

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So now we look at lower 48 states.

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Alaska is a little too far, but we just looked at one Alaska is a little too far and Hawaii.

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We'll just have too much fun if we go to Hawaii all the time.

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Good excuse.

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So, backtracking a little bit, you said that your father scrapped up some money and bought his very first business, which ultimately was the catalyst for what has become now, uh, cedar Crest Capital.

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What was that first business that he bought?

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The first business that he got into was, uh, actually a jewelry business in old town, Scottsdale.

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I did that for a year.

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He absolutely hated it.

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Um, you know, his neighbors would just undercut prices against each other for the same product and he was like I'm, I'm out, Uh.

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And then he went to Sacramento, opened up a bagel store there, uh, bagels I love it and then he did a souvenir store in old town Sacramento.

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Then he came here at T-Sol Weeji's pizza in Tempe and then, uh uh, gotten to the carwash space before it was a hot space.

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And that's when I think that's where he learned the most and probably made the most of his earnings, and that's when his mindset changed about how he should be looking at businesses.

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When he owned the car wash yeah.

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So as a kid I was getting real life business lessons from him, and being a business owner is extremely difficult.

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I used to see his stress.

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He wasn't sleeping well, staying up all night.

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Uh, you know the personal guarantee stressing him out right, if you, if you do one mistake.

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He lost his house, we lost our house.

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So I got to see that pressure.

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You know people think buying a business or running is very easy.

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It's probably the hardest thing you could ever do.

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Um, cause you have you have your employees lives at stake, right?

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They rely on you to perform and and your family relies on you and, at the end of the day, if you don't perform, the bank will take we'll take everything.

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Yeah, for sure.

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Yeah, so we saw that stress firsthand and and, uh, you know, surprisingly it didn't scare me away from wanting to go down this path.

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But here we are.

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No, that's interesting, you say before it became a hot space, because I do think uh the mindset and maybe this is part uh social media influencing.

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But the carwash space has blown up and it's crazy now how commoditized the carwash scene is.

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Right, because originally I mean, I remember being younger and it's like you pull up and it's a flat fee, there's no subscription and then everyone learned that subscription-based car washes were a way to make more money off of your car wash location.

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So that's fascinating.

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But I think you made a really good point, which is that you know, I think a lot of smaller business owners think that the pressures of operating their business as a solo or a small team has sometimes crushing pressure.

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But think about when you grow exponentially and all of a sudden, like with a personal guarantee or you having a whole team of employees relying on you.

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You know, if your business flounders for a period of time, what does that look like for your personal life and for the life of all of your employees.

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So I think that was a really good point to make and I think, something that people don't realize that as you grow, so does the stakes at play.

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So you touched on this earlier about how you fit this niche area where you're not, you're kind of slipping in, where there's maybe not as many potential buyers to fill this gap, and you mentioned a little bit about how private equity doesn't really fit into that space.

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Can you go into it a little bit more as a potential buyer of these?

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You know more traditional businesses, how you're different than private equity.

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Yeah.

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So PE is starting to come downstream.

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We're starting to see them a little bit in our space, which is scary.

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But also we welcome competition so we're excited for it.

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But we're completely different from private equity.

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Let's break it up into two pieces.

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There's the before the deal side and then there's after the deal side.

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So the before deal side PE they have outside money, they have outside investors.

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That requires them to do crazy due diligence.

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They ask for maybe 1,000 items in due diligence and only 15 of those 1,000 are actually important for the deal.

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The other items are just to check their box because in the event they buy this company and they're wrong and they get sued by their investors.

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They can prove in their lawsuit that they actually did the proper due diligence.

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Unfortunately, small business owners don't know what a quality of earnings is.

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They don't know what these items are that big PE firms ask for and it ends up burning out the sellers because the seller is still running their business.

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So now, if they're answering to a thousand questions and thousand items and they're also trying to run their business, let's say the p firm decides, hey, we're going to walk away.

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You know that business has tanked during that due diligence period because they've taken their head away from what's actually at stake to focus on these random requests that are not necessary.

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So that's on the pre-deal side.

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P firms tend to be a lot slower in the transaction closing process and much more tiring.

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So for us, you know we we have one single LP, but it's essentially, it's essentially internal family money at this point.

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You know I've worked with them for a handful of years.

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There's a level of trust there.

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So we approach it from the sense of you know, we don't have outside money.

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We will ask you the 15 items that actually matter.

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You're dealing with the decision makers directly.

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There's no investment committee that we have to report to.

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So we can, we can close a deal within 45 days, um, from start to finish, which is pretty quick in the investing world.

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You know PE.

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I say typically, yes, there are some P firms that can be quick, but typically they're 60 to 120 days on average, which is a long period of time.

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I would agree with that, and that's on the pre-close.

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On the post-close, I would say it's even more important.

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You know private equity.

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Their model is hey, we're going to go and we're going to buy this business and we're going to sell this in five years, because that's when we have to return capital back to our investors.

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We're going to, we have to grow this thing 10% per year and, unfortunately, forced growth is very risky to a business.

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You're either going to fire people to boost up profitability, which hurts a business, or you're going to inefficiently spend money on marketing R&D, which is a bet that may or may not pay off.

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If it pays off, great.

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If it doesn't, you're just burnt through all these resources and at the end of the day, they are going to sell the business, which means that brand might disappear, those employees might not be taken care of.

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Our model is it's not broken.

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Why break it?

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The business has been making great cash for a long time.

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All we want to do is cash out that founder or family, put somebody in place to maintain what's been how it's been historically and that allows us to keep the employees forever, keep the brand forever, keep that culture intact.

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And the way that we make money is from the distributions of the profit the business has been producing historically.

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We're not saying we're anti-growth, we're saying we're anti-forced growth.

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If the business happens to grow, great.

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If it doesn't, we sleep well at night and that's what allows us to keep the business forever and we don't have to return capital back, you know, in five years, like a typical private equity firm.

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So it allows us to really focus truly on the long term.

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And the hardest part of our job is finding a good business or good people hands down.

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So why do you want to sell it in five years once you find something you like?

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We don't want to.

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We want to keep it forever.

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So that's what makes us a little bit different.

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I like that.

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I think a lot of people don't realize the disconnect between, like you had mentioned earlier, wanting to preserve your legacy but maybe not having the family members to to do that.

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And you're right, there's a lot going on right now where kids aren't interested in buying the boring business from mom or dad.

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Um, I want to do the tech stuff.

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No, yeah, they want to do the cool, they want to be influencers, they want to do this the easy button, um, and obviously that's not always the case, but I think, unfortunately, you get a lot of unsexy businesses that are cash flowing really well and they don't have the family members to take them over, and so in some instances they do get sold to, you know, private equity groups that perhaps don't have their best interests at heart, and so you know, I think, at the heart and soul of every business owner wanting to sell that has that, you know, blood, sweat and tears invested from, you know, long, long time ago, cashing out is a part, big part, of that equation, but also maintaining the legacy that you built and seeing your business continue on and supporting those employees that have seen you through thick and thin that can sometimes get lost in translation.

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I liked that you also talked about the due diligence process for private equity, because I don't think people really know, for starters, right, they don't always know that that's part of the process, but they also don't realize just how cumbersome and, quite honestly, a little ridiculous the number of questions.

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I'm going through a transaction right now that has private equity on the other side and they have asked the same question about three or four different ways and my client has kind of looked at me and said why I've answered this question and I'm like that's just how this goes right, just just regurgitate your answer.

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They're regurgitating their questions.

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It'll go in a big circle, but I like that you gave context in the background of of why that is the case.

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Right, it's a checking off of the uh, the boxes right as part of their process.

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You know backstory on that.

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Uh, my dad had a business that he was selling, probably a few years ago Probably.

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Back when we approached him and I'm his quasi-banker, you know I help him out when I can and they asked for 1,000 items and one of those being, you know, quality of earnings from EY, which is, you know, one of the big four and my dad's business he's a small business, it's not a big business.

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He comes over to me he's like hey, what is this, what's this QOV thing from EY?

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I was like we're done talking to him, we stopped talking to him, we cut it off.

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They were just going to kick the can down the road and just waste his time.

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And a strategic actually stepped up to the table and understood the industry and was able to ask, you know, 15, 20 items and got the deal closed.

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You know there are very friendly strategics and there are, you know, not friendly strategics which we can hit on, you know, later on in this conversation.

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No, I like that.

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So you know, I like this idea of holding on to a business for a period of time until maybe it makes sense at some point in the future, and this idea of continued growth, not necessarily forced growth, especially because I think a lot of business owners they miss the connection.

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If there is an earn out right, there's something tied to post closing performance.

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If, say, private equity were to come in and make the purchase and there's an earn out tied to it, what is their forced growth plan ultimately going to do?

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Granted, at first glance you're probably like, oh, the forced growth plan ultimately going to do?

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Granted, at first glance you're probably like, oh, the forced growth is going to just cause my earn out to be amazing.

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But to your point, what are they going to cut in the process?

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What are they going to change in the process that ultimately might negatively impact the EBITDA in the following years?

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And I mean, you see, you know things firsthand in the field.

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But also you hear of stories in passing about, you know, companies beginning even not private equity, right outside of that, people coming in and blowing up existing processes that are in the business that are doing well, just because they don't like how it's done and all of a sudden the earn out is completely gone or wiped out.

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So growth and change are very risky to a business In some ways.

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People preach if you don't change, you're going to end up killing your own business over time.

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That's why what we focus on tech can't disrupt it.

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So if we don't change anything, it's not like some new technology is going to come in and disrupt this business next year.

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We can maintain how it's been performing and we'll be okay and that's what allows us to be comfortable with okay.

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You know we don't have to go in here and blow things up to stay competitive.

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We can maintain the culture, the employees, the brand, everything as is.

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But back to your question of you know forced growth.

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You know change p coming in.

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They have to grow this.

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It question of you know forced growth.

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You know change PE coming in.

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They have to grow this.

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It's a bet.

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You know some cases they might do very well and they might grow this thing and everyone might be happy.

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In other ways they're taking a risk right.

00:18:07.484 --> 00:18:12.837
Anytime you make a change to something that's already been working, there's a risk you could break it and it happens a lot.

00:18:12.837 --> 00:18:20.230
So that earn out definitely is not going to be hit and if they rolled equity over, the equity is probably also going to take a hit.

00:18:20.230 --> 00:18:21.694
But that's what happens.

00:18:21.694 --> 00:18:25.257
And we tell everybody look, you know, they sit across the table from us.

00:18:25.257 --> 00:18:26.323
We talk to sellers all the time.

00:18:26.323 --> 00:18:29.316
They're like what would you do, what's your strategy with this business?

00:18:29.316 --> 00:18:44.469
And I tell them I'd be an idiot if I sit here and tell you because I don't know, I have to go into your business, give me six months to learn it, and then from there I'll tell you what I think, where we can go with this.

00:18:44.469 --> 00:18:47.556
Um, and you have a strategics and PE firms come all the time say, oh, we're gonna do this, we're gonna do that, we're gonna fix this yeah, how do they know?

00:18:47.596 --> 00:18:51.748
I don't know I mean they're they're gonna know more than the owner, who's been doing this for 40 years.

00:18:51.748 --> 00:18:53.852
So we just tell them straight we don don't know.

00:18:53.852 --> 00:18:55.013
I have no clue.

00:18:55.013 --> 00:19:00.292
What I do know is I want to keep everything you have in place and then, if we find some sort of opportunity, then it'll come up.

00:19:00.292 --> 00:19:00.835
But it won't be.

00:19:00.835 --> 00:19:04.015
And day one, day 60, you know, six months to a year type of thing.

00:19:04.586 --> 00:19:27.290
So, as a potential buyer in the market and as a listener who's maybe a business owner, they would, of course, want to know what businesses are you potentially targeting as a potential buyer out in the market and what makes those businesses particularly advantageous, or something that you look at and you're like we need to buy this ASAP.

00:19:27.854 --> 00:19:32.166
So I think, I think a lot of investment firms are so focused on chasing elephants.

00:19:32.166 --> 00:19:33.910
You know they're trying to hit a home run.

00:19:33.910 --> 00:19:34.711
We're going after singles.

00:19:34.711 --> 00:19:35.592
You know they're trying to hit a home run.

00:19:35.592 --> 00:19:36.192
We're going after singles.

00:19:36.192 --> 00:19:40.279
You know we are focused on non-digital businesses that have been around for a long time.

00:19:40.279 --> 00:19:43.875
We don't like spikes in growth.

00:19:43.875 --> 00:19:46.948
You know we want consistent earnings that have been around for a while.

00:19:46.948 --> 00:19:48.537
There's a proven history there.

00:19:48.858 --> 00:20:02.542
We want the business to have been around for at least 10 plus years and for us, the most important questions we ask us can this business run without the owner?

00:20:02.542 --> 00:20:03.094
Meaning, is the owner a key person in the business?

00:20:03.094 --> 00:20:04.028
Are they ahead of sales, ahead engineer for a certain product, or is it more?

00:20:04.028 --> 00:20:04.852
They're taking care of their employees, taking care of the customers?

00:20:04.852 --> 00:20:10.940
You know, dealing with the typical business things that we can replace, um, you know that's certain type of things we look for.

00:20:10.940 --> 00:20:15.346
There's a framework we like to use and we're going to give you some little confidential stuff here on on the podcast.

00:20:15.548 --> 00:20:18.665
Uh, one, uh, can amazon replace this business?

00:20:18.665 --> 00:20:21.938
Two, has this business been around for 10 plus years?

00:20:21.938 --> 00:20:26.089
Three, is this a simple business to understand, meaning low to no technology?

00:20:26.089 --> 00:20:29.416
Four uh, can you predict the cash flow?

00:20:29.416 --> 00:20:30.827
It must have a repeat customer base.

00:20:30.827 --> 00:20:39.090
Here in this state we have a lot of uh contract contractors, construction which are great businesses, but the problem with those you're always chasing the next project.

00:20:39.090 --> 00:20:41.030
So for us it's difficult.

00:20:41.030 --> 00:20:43.151
You're always chasing the next customer.

00:20:43.151 --> 00:20:49.334
We don't want to be in that type of business, but there are other folks that make a lot of money doing that and that's their specialty, just not ours.

00:20:49.785 --> 00:20:50.846
Okay, so not trades, not trades.

00:20:51.226 --> 00:20:52.287
Not digital Yep you like brick and mortar.

00:20:52.446 --> 00:20:53.847
Yeah, you like brick and mortar.

00:20:54.689 --> 00:20:54.929
Yeah.

00:20:54.929 --> 00:20:57.912
Maybe, when people say brick and mortar I think of like a retail store.

00:20:57.971 --> 00:20:59.333
Okay, we don't have to use brick and mortar.

00:20:59.692 --> 00:21:04.676
Business services, consumer services, light manufacturing, niche distribution, healthcare services.

00:21:04.676 --> 00:21:15.419
Those are areas where we feel like there's a lot of non-digital opportunities, businesses that have been around for a long time and businesses that we need.

00:21:15.419 --> 00:21:25.594
There's a lot of businesses out there that people don't necessarily need, that produce good cash flow but at some point in time it might get cut off.

00:21:25.594 --> 00:21:27.479
I'll give you some businesses that we've looked at historically that we really liked.

00:21:27.479 --> 00:21:31.787
You know there was a police car manufacturer we worked on that one.

00:21:31.807 --> 00:21:32.008
Yes.

00:21:33.270 --> 00:21:47.974
No, it is a project based business, because you have to make the police cars, but those municipalities are coming back to you every three to four years, so in a sense, you have a repeat customer still, um, and that's a great business, because you're always going to need that, no matter what's happening in the world.

00:21:47.974 --> 00:21:52.530
And, uh, so that's one of the things, right, technology can't really change that.

00:21:52.530 --> 00:21:56.536
Uh, these are highly customized, so you can't put them on the assembly line, right.

00:21:56.536 --> 00:21:59.133
These are highly customized, so you can't put them on the assembly line, right.

00:21:59.133 --> 00:22:00.480
Every municipality has their own requirements for what they want.

00:22:00.480 --> 00:22:00.761
So that was.

00:22:00.761 --> 00:22:01.444
That was a very interesting one.

00:22:02.627 --> 00:22:10.313
Metal plating is one that we're involved with, right now that all they do is they coat parts that go into commercial planes.

00:22:10.313 --> 00:22:13.844
You're always going to need that especially what's happening?

00:22:14.164 --> 00:22:14.546
in the world.

00:22:14.546 --> 00:22:19.741
So things like that, things that people may not necessarily think about.

00:22:19.741 --> 00:22:24.632
There's a business that we're looking at now in California.

00:22:24.632 --> 00:22:29.358
They actually create the ICU for you at home.

00:22:29.358 --> 00:22:33.894
So let's say, you know you were born with a complication and you're in ICU.

00:22:33.894 --> 00:22:41.617
They will actually set up the whole ICU system in your house so that you don't have to be in the hospital and the family can be with the child at home.

00:22:41.617 --> 00:22:46.195
Nice, and that's a business that you'll always need.

00:22:46.236 --> 00:22:46.457
Yeah.

00:22:47.765 --> 00:22:52.415
And it's solving a problem and, yeah, it's one that gets us excited.

00:22:52.415 --> 00:22:53.178
So things like that.

00:22:53.178 --> 00:22:57.509
You know, trades are tough for us, construction is tough for us.

00:22:57.509 --> 00:23:01.634
As long as it hits those four criteria, it's something that we'd probably be interested in.

00:23:02.236 --> 00:23:13.955
Okay, we talked a little bit around the idea of businesses that have key man syndrome or, you know, to make it more PC key woman syndrome potentially.

00:23:13.955 --> 00:23:28.525
To make it more PC key woman syndrome potentially, but the the idea right being that there's one owner and without that owner, the business really ceases to exist or would run into some big operational issues.

00:23:28.525 --> 00:23:33.972
Now you're, in a lot of times, coming in and and adding an operator to the business.

00:23:33.972 --> 00:23:45.271
Is that a way for you to sidestep the key man syndrome or do you feel like, no matter what, if someone is experiencing that sort of key operator issue, it's almost impossible to overcome?

00:23:45.913 --> 00:23:46.335
It depends.

00:23:46.335 --> 00:23:50.255
Well, we put our operating place to replace whatever the owner was doing.

00:23:50.255 --> 00:23:53.271
It's really for handling, payroll.

00:23:53.271 --> 00:24:02.251
You know handling, you know P&L, making common sense, business decisions, dealing with employees, making sure they're taken care of, making sure that the customers are taken care of.

00:24:02.251 --> 00:24:05.474
That anybody with some sort of business knowledge can do.

00:24:05.474 --> 00:24:12.730
Where we don't touch is if the owner is the head sales responsible for all the relationships.

00:24:12.730 --> 00:24:17.675
Then we don't know are those clients loyal to the business or loyal to you?

00:24:17.675 --> 00:24:18.665
And we don't know.

00:24:18.665 --> 00:24:23.375
We can maybe find out due diligence, but it's a bet.

00:24:23.375 --> 00:24:27.955
So those are the ones where, quite frankly, we just walk away, unfortunately.

00:24:27.955 --> 00:24:34.194
And if you're strategic and you're in the space, maybe they can get comfortable because they're already in the industry.

00:24:34.194 --> 00:24:38.051
Right, they can bring in one of their team members who's an expert in this space, who has relationships.

00:24:38.792 --> 00:25:02.950
Um, that's different, but from our standpoint it's very hard for us to replace what that owner is doing yeah unfortunately we have to pass on a lot of stuff for that reason and we tell folks all the time you know, bring us in early enough, we can tell you what to do and what to improve and what flags that other people might look out for, and then they have time to kind of work on that and bring in the right people, transfer that knowledge over.

00:25:04.826 --> 00:25:07.734
Get some SOPs in place standard operating procedures.

00:25:07.734 --> 00:25:30.080
No, I appreciate that because I don't think it's black and white and I think in a lot of instances, if you do get to somebody in advance you know I talk a lot of instances if you do get to somebody in advance, you know I talk a lot with clients who are planning four, five, six, seven years out, right From exiting, and you know the conversation always revolves around what can I do?

00:25:30.101 --> 00:25:30.622
to prepare and plan.

00:25:30.642 --> 00:25:31.022
What am I not doing?

00:25:31.022 --> 00:25:36.213
And one of our you know the questions I like to ask is can you take two weeks and not take?

00:25:36.273 --> 00:25:36.615
a phone call.

00:25:36.615 --> 00:25:38.598
I like to ask is can you take two weeks and not take a phone call?

00:25:38.598 --> 00:25:38.699
Not?

00:25:38.759 --> 00:25:53.130
take an email right, because almost 99% of the time the owner's, like my business, would blow up or there would be things that go wrong, or the idea of stepping away wholeheartedly for two weeks and going radio silent is an impractical part of their business.

00:25:53.170 --> 00:25:57.375
So I think it tends to highlight that key operator syndrome issue.

00:25:57.375 --> 00:26:11.355
So I think, as a business owner, a follow-up question that I would want to ask is if you're putting in these operators post-closing and let's say I don't have a key operator issue.

00:26:11.355 --> 00:26:20.050
Maybe I have some stuff that I need to hand down, but I can do that with certainty what does it look like for me post-closing working with you guys?

00:26:20.050 --> 00:26:23.102
Am I on a consulting basis with you?

00:26:23.102 --> 00:26:24.969
Am I transitioning for 30 days?

00:26:24.969 --> 00:26:31.869
Is it more long-term or is it really depending on the type of business and, obviously, the operator's involvement?

00:26:32.131 --> 00:26:36.009
We like to I mean obviously every, for everything, it depends, but we like to ask for two months.

00:26:36.028 --> 00:26:37.011
Sounded like an attorney.

00:26:37.353 --> 00:26:38.355
I'll protect myself.

00:26:38.355 --> 00:26:39.925
You've taught me well.

00:26:39.925 --> 00:26:43.051
You know we need typically two months transition period.

00:26:43.051 --> 00:26:46.979
That's just us with you, you know, side by side, trying to absorb as much as we can.

00:26:46.979 --> 00:26:59.842
And then from there we'll have a consulting arrangement where, if something comes up, you know, we'll pay you for your expertise, but we don't require them to stay on board for a year, two years, which you hear in a lot of private equity transactions.

00:26:59.842 --> 00:27:03.356
You know, uh, we truly want to be an out for you, we want to be succession plan for you.

00:27:03.356 --> 00:27:05.566
Um, and that's what we, what we stand by.

00:27:05.566 --> 00:27:08.512
So give us two months and then go off into Hawaii and do whatever you want.

00:27:08.512 --> 00:27:11.828
Um, you know, we're not going to keep you for two, three years.

00:27:11.828 --> 00:27:13.273
At that point, just keep the business.

00:27:22.065 --> 00:27:22.926
Yeah, just make all the profit to yourself.

00:27:22.926 --> 00:27:49.298
Well, and I think too a lot of people who are at that stage where they want to cash out of their business, they're ready to be retired, right, and so this idea that, you know, private equity or not being kept on board for a year or more in some instances is not optimal, or maybe their health is not in the best place and they can't physically be on board for a year or two, and so I think that it's something that every business owner doesn't really consider until the LOI hits their desk and, all of a sudden, there's a two-year potential contract for them.

00:27:49.665 --> 00:27:51.319
Something we tell a lot of people.

00:27:51.319 --> 00:27:55.175
You know a owner will have a very hard time becoming an employee.

00:27:55.175 --> 00:28:05.609
So if you're going to ask them to stay on board for a year or two years, they're now an employee, right, and there will be clashing, there will be fighting and there will be disagreement on stuff.

00:28:05.609 --> 00:28:08.012
And they're not wired like that.

00:28:08.012 --> 00:28:08.795
They're entrepreneurs.

00:28:08.795 --> 00:28:12.869
You know they built this company from the ground up and that's what they've done for 30, 40 years.

00:28:12.869 --> 00:28:23.708
So for you to tell them to stay on board to be your CEO or something, it's just it just sounds very messy.

00:28:23.788 --> 00:28:25.332
It's not going to work.

00:28:25.332 --> 00:28:28.923
Well, it's like the equivalent when you hear about publicly traded companies removing their uh, you know their CEO, or I forget.

00:28:28.923 --> 00:28:36.126
It's like the president or CEO and they've swapped them into a role that is more a consulting you know, advising role.

00:28:36.126 --> 00:28:38.136
They're not actually handling the daily operations.

00:28:38.156 --> 00:28:39.020
Like executive chairman.

00:28:39.020 --> 00:28:41.311
Yeah, yeah, they take the CEO and make him executive chairman.

00:28:41.365 --> 00:28:47.251
You're still part of the business, but you're not really in charge of it anymore, and those always implode.

00:28:47.392 --> 00:28:47.573
Yeah.

00:28:47.625 --> 00:28:49.933
Because, to your point, they can't take a back seat.

00:28:49.933 --> 00:28:57.356
They either have to be fully removed or they have to be in a very limited consulting position, which I think they even struggle with, sometimes mentally.

00:28:57.396 --> 00:28:59.086
anyway, yeah, something.

00:28:59.105 --> 00:29:01.835
We've realized a lot and I think we should definitely hit on this.

00:29:01.835 --> 00:29:20.127
What we do I say 70% of the time we're psychologists, we're not investors, because in the segment that we play in, these are first-generation business owners and for them, this is their child, this is their baby.

00:29:20.127 --> 00:29:22.232
They built this 40 years ago, 30 years ago.

00:29:22.232 --> 00:29:25.007
This is the most important thing to them, this is their identity.

00:29:25.007 --> 00:29:48.450
It's extremely important to who they are and where we have most challenges, and the stuff we face is they have a hard time letting go, and it breaks our heart when we hear about sellers unfortunately getting ill or something happening to them and they just shut the doors down Happens all the time.

00:29:48.450 --> 00:30:03.053
And now their family left millions of dollars on the table that they could have exited, but sellers wanted to keep working until, unfortunately, something happened to them and we are trying to prevent that.

00:30:03.053 --> 00:30:08.454
So we're out here trying to speak to as many people as possible because we want them to know that, hey, you have this option.

00:30:08.454 --> 00:30:11.634
People don't realize they can sell their business for millions of dollars.

00:30:11.744 --> 00:30:14.483
They're just like we're just going to shut our doors, we're going to retire.

00:30:14.483 --> 00:30:18.373
So it's that psychological angle which is actually probably the hardest part of what we do.

00:30:18.373 --> 00:30:37.118
It's not finding the deals, it's not finding them, it's none of it's, it's the psychological piece that's by far the hardest part of what we do it's so true it's so tough so, so true and so tough, because I feel like there's this window for a lot of business owners where they're still very capable.

00:30:37.625 --> 00:30:51.971
The finish line is not anywhere in sight and things are really busy because things are going well and the idea of carving out time to prepare your business for a sale doesn't exist or they don't make the time.

00:30:51.971 --> 00:30:53.912
And so I think to your point.

00:30:53.912 --> 00:31:06.021
Having conversations earlier, I think it's a critical component of preparing this sort of handing off of potential generational wealth.

00:31:06.021 --> 00:31:16.097
Right and we always kind of just talk in passing about this between myself and my clients is that you know this is not something we're doing.

00:31:16.097 --> 00:31:18.621
You know, it's almost like estate planning in a way.

00:31:18.704 --> 00:31:25.478
It's really hard to get people to understand the value of putting together a will when there's nothing wrong.

00:31:25.478 --> 00:31:55.473
Yeah, but it's the same version of what you do for your business, because one day something could be wrong and if you haven't spent the time which it takes considerable time to put in all of that sort of standard operating procedures, all of the sort of the Bible of your business, right, or whatever you want to call it, your operating manual that you can then go to as someone outside of the company and be able to page turn through and figure out how to operate it even in your absence.

00:31:55.473 --> 00:32:00.497
So I really like that idea of being able to have these conversations earlier.

00:32:00.497 --> 00:32:10.136
I know there are certain pockets of the United States that are seeing more of their businesses just disappear because of this, because they don't know, which is wild to me.

00:32:11.026 --> 00:32:14.482
staples in communities that are just and all your employees now lost their jobs yes.

00:32:14.482 --> 00:32:16.673
They're out of jobs, probably lost their insurance.

00:32:16.673 --> 00:32:23.951
It gets there's not just them, you know there's other people that rely on them, and I think they forget that sometimes.

00:32:23.971 --> 00:32:31.878
Yeah, um, yeah, so something, something we've been testing the waters with is, let's say, you are maybe five years out from retirement.

00:32:31.878 --> 00:32:41.465
You know, instead of getting the phone call at year five when like, hey, I'm what, if you want to take some chips off the table, bring us in, you know, we'll buy maybe 51% of the business.

00:32:41.465 --> 00:32:43.652
Therefore, they have some chips off the table.

00:32:43.652 --> 00:32:45.236
They've de-risked themselves a little bit.

00:32:45.236 --> 00:32:46.869
Now they can really.

00:32:46.869 --> 00:32:52.228
You know, they have some money in the bank and they want to run it another five years with a partner that we can maybe help them.

00:32:52.228 --> 00:32:54.330
Have you thought about this?

00:32:54.330 --> 00:32:54.872
What about this?

00:32:54.872 --> 00:32:55.532
Have you thought about this?

00:32:55.573 --> 00:33:19.826
bring a different perspective and then in five years, when they're like, okay, I'm now, I'm ready, we're already there, we'll just, we'll purchase the remaining piece of the business I like that um so that's something we've been testing a lot with recently, because we're seeing a lot of folks that are, you know, maybe to the outside world it's retirement age, but they still have so much energy and there's so much fire in them and they just want somebody to come and go through the trenches with them and we and we can do that.

00:33:19.826 --> 00:33:26.334
Um, and it gives us an end, essentially because in five years when they went out, we're already there, we already have a relationship.

00:33:26.334 --> 00:33:26.915
It makes it easier.

00:33:27.685 --> 00:33:28.586
Yeah Well.

00:33:28.586 --> 00:33:39.650
And to come in and potentially learn the ins and outs but also be introduced to key clients or customers or whatever the vendor relationships right.

00:33:39.650 --> 00:33:49.276
To have that person be live in the office with you, essentially handholding you through this process of phased buyout, is, I think, an incredible approach.

00:33:49.317 --> 00:33:50.338
Minimizes a ton of risk.

00:33:50.765 --> 00:33:52.627
Yeah, absolutely so.

00:33:52.627 --> 00:34:00.299
I think you know we both have gone through quite a number of acquisitions and advised from a different perspective in different ways.

00:34:00.299 --> 00:34:04.090
I'd love to hear a story from the trenches, if you have one.

00:34:04.090 --> 00:34:20.860
For us that was either a win or something that was a hurdle that just couldn't be overcome, just from the perspective of a potential business owner, to know what are the potential pitfalls or things that could create ripples in the transaction process um, good question.

00:34:21.820 --> 00:34:22.943
There's a lot of war stories.

00:34:22.943 --> 00:34:25.246
Let me let me decide which one I want to pick on.

00:34:25.246 --> 00:34:31.985
Um, there was uh, I guess there's one that I can talk about that mentioned names.

00:34:31.985 --> 00:34:39.164
Um, you know, we, we don't like earnouts, we like businesses that are fairly stable and steady.

00:34:39.344 --> 00:34:41.291
Therefore, I'm going to pause you in the middle of your story.

00:34:41.873 --> 00:34:56.347
Tell everyone why you don't like earnouts so earn out essentially is let's say, you believe your business is growing and we we don't know personally, you know we don't know what's going to happen, and so we will, you know, pay a price based on that future growth.

00:34:56.347 --> 00:34:58.275
You know that's going to happen and so we will, you know, pay a price based on that future growth.

00:34:58.275 --> 00:35:10.335
You know that's the total price, but the cash that will give you our closing is a little bit less than that and if we hit, and if we hit these hurdles, you know, next two years you will get paid out that the non, the total purchase price.

00:35:10.335 --> 00:35:17.577
So sellers like it because you know they feel like they have another, another bite at the apple.

00:35:17.577 --> 00:35:30.969
Essentially, if things go well, they make some more money and buyers not us, but other buyers do like to use that tool because it's a way to bridge a gap in negotiation For us.

00:35:30.969 --> 00:35:32.695
We try to be extremely transparent.

00:35:32.695 --> 00:35:36.114
We are never going to dangle a carrot that we don't think is achievable.

00:35:37.846 --> 00:35:47.873
And there was a deal we were working on where the business had a spike post COVID, as most businesses did, and we did not know what was normal, you know, is that?

00:35:47.873 --> 00:35:49.925
Is that going to reoccur?

00:35:49.925 --> 00:35:51.449
I keep hitting my mic.

00:35:51.449 --> 00:35:53.715
Is that going to reoccur the next two years?

00:35:53.715 --> 00:35:55.146
Is that going to reoccur?

00:35:55.146 --> 00:35:55.907
Maybe in one year?

00:35:55.907 --> 00:36:02.775
And it was adding too much risk to us and we could not come to an agreement with the seller on that component.

00:36:02.775 --> 00:36:04.692
We came to an agreement on the total price.

00:36:04.692 --> 00:36:06.012
We came to an agreement on the working capital.

00:36:06.012 --> 00:36:10.333
We came to an agreement on almost everything and we had a lot of respect for that seller.

00:36:10.333 --> 00:36:26.416
But on the specific earn out, given the way that the industry was going, if it hit in that first year and then in year two everything stabilized back to what it used to do, we would have significantly overpaid for that business and that was a risk to us and we were not willing to take that risk.

00:36:26.416 --> 00:36:32.126
Now, if it was a two-year earn out, we were ready to close the deal and the only reason we put that earn out in place?

00:36:32.126 --> 00:36:34.550
Because the business didn't have the, the earnings history that we like.

00:36:34.550 --> 00:36:44.436
And I continue to repeat myself to the seller you know, if you had history, you know three, four years of earnings at this level, we would pay you all cash at close and we'd walk and it'd be a done deal.

00:36:44.436 --> 00:36:49.077
So earn out only comes into play for us when you don't have that historical history.

00:36:49.077 --> 00:36:53.371
Otherwise, you know we want to pay you full cash at close.

00:36:53.371 --> 00:36:59.891
We want to buy as much of it as possible because for us, you know, we're fairly selective in the things that we do.

00:36:59.891 --> 00:37:02.927
Um, when we find something we like, we want as much of as possible.

00:37:03.809 --> 00:37:10.693
And I think earn out can get messy with a lot of people because then you're gonna decide revenue, earn out, gross profit, earn out, ebitda, earn out.

00:37:10.693 --> 00:37:13.306
You know some people say you can manipulate ebitda earn out.

00:37:13.306 --> 00:37:15.931
Right, you can put more costs in there, which reduces it.

00:37:15.931 --> 00:37:17.172
So as a game you can play revenue.

00:37:17.172 --> 00:37:23.126
It's harder to play with revenue but then your cogs can go up right Out of your control.

00:37:23.126 --> 00:37:24.030
Inflation can happen.

00:37:24.030 --> 00:37:25.293
Now your gross profits a lot less.

00:37:25.293 --> 00:37:27.610
You know revenue is hit, so they're messy.

00:37:27.610 --> 00:37:28.913
We just try to avoid them.

00:37:28.913 --> 00:37:33.050
But you probably have a lot of earn out stories from your deals.

00:37:33.572 --> 00:37:40.186
You know I think earn outs are stories from your deals.

00:37:40.186 --> 00:37:40.809
You know, I think earnouts are.

00:37:40.809 --> 00:37:54.208
They're really scary for a lot of my seller clients because even though they have historical financials that show that the earnout should be, for all intents and purposes, no problem the idea that they're not getting the full value of their purchase price.

00:37:54.208 --> 00:38:00.873
If something were to happen post-closing and all of these what-ifs come into play right, they're no longer at the helm.

00:38:00.873 --> 00:38:09.965
The buyer could come in and start making changes and in a lot of cases the buyer isn't like you guys representing that they could.

00:38:09.965 --> 00:38:13.268
They're going to not change anything to make these drastic changes.

00:38:13.329 --> 00:38:49.556
So the biggest concern right is that they come in and they wipe everybody out, and so I think that from an earn out standpoint, I've seen the chips fall to the benefit of more of the buyer side than anything, because you do have so much variability and especially and I know this isn't necessarily an area that you guys specialize in, but I work a lot with professional service businesses and even if those services can be performed by, say, another accountant, people love their accountant.

00:38:49.556 --> 00:38:51.018
They're tied to that person.

00:38:51.018 --> 00:38:53.833
It's the same with a physician practice they love their physician.

00:38:53.853 --> 00:38:55.085
So I give you four of the criteria.

00:38:55.085 --> 00:38:56.610
Number six was no professional services.

00:38:56.670 --> 00:38:58.514
Yes, I forgot that was in your list.

00:38:58.514 --> 00:39:21.032
So, like you know, I just I feel like it's difficult when I'm, you know, working with a client that's in a professional service business, for them to have an earn out and to to sit there and tell them this isn't going to impact you because inherently you have attrition, because you are tied to the business in some personal capacity and replacing you, I think, is an art form that's.

00:39:21.032 --> 00:39:30.085
A broader conversation that I talk about with my clients is when they're selling and it is based on their, you know, personal relationships with their clients.

00:39:30.085 --> 00:39:33.032
How can we make that transition a lot less scary?

00:39:33.032 --> 00:39:47.255
Because inevitably you're introducing someone new to take care of an important part of their life, and I think a stepped approach that you know relies, to your point, on psychological aspects where you're introducing people.

00:39:47.255 --> 00:39:50.472
As this is someone who's going to come in, we're going to make this gradual.

00:39:50.532 --> 00:39:58.686
You're going to get to know them things to lessen the burden, but to your point, you always have to play a psychological role in this process.

00:39:58.927 --> 00:40:01.114
Yep, 100%.

00:40:01.114 --> 00:40:10.887
You know something I I always tell bankers all the time they're like well, no post, close, you can change things that hurt the business and therefore you know the earn out is destroyed.

00:40:10.887 --> 00:40:17.610
We say, well, if, if you move out, if you remove the owner and the business falls to the ground, do you really have a business?

00:40:18.914 --> 00:40:19.235
It's true.

00:40:19.945 --> 00:40:20.909
Is it a business at that point?

00:40:20.990 --> 00:40:21.311
It's true.

00:40:22.166 --> 00:40:23.893
So that's something that we always pitch.

00:40:23.893 --> 00:40:27.494
If you remove that one person and the business falls to the ground, it's not a business.

00:40:27.494 --> 00:40:29.079
They're too involved.

00:40:29.922 --> 00:40:32.467
No, absolutely, and I think to your point earlier.

00:40:32.467 --> 00:40:48.088
You had said there's ways to play with EBITDA where earn out, or essentially the way that the remainder of the purchase price is paid to the seller, is inflated or deflated manually through a calculation.

00:40:48.088 --> 00:40:50.034
That's just all relying on math, right?

00:40:50.034 --> 00:41:28.699
And I think that one important thing to note is that there are ways to have an adjustment to the EBITDA during the earn out phase to essentially add back in, like you were talking about, management fees and all these things that could be pulled out, which I know that's outside the scope of what you guys like to do, but especially for them, they tend to have issues with rebates and discounts and all these other things, retention stuff that's pulled out, that needs to be added back in so that your EBITDA and the earn out ultimately is correct.

00:41:28.719 --> 00:41:41.552
Yeah, so I guess it just comes down to finding that right formula that is industry specific and that's where the lawyers have fun, because they get to write out like three pages just on a math equation and it gets really messy.

00:41:42.164 --> 00:41:43.307
No, I have to say.

00:41:43.307 --> 00:41:50.625
Nothing is more mind boggling than trying to take math and put it in words and have it make sense for all the parties reading the contract.

00:41:53.373 --> 00:42:05.757
Yeah, we went through that and there was, I think it was like two pages just for the math formula, that's overkill and I'm in there sitting trying to convert it back from words to math and I'm like okay, reverse engineering.

00:42:05.777 --> 00:42:06.378
How does this work?

00:42:07.666 --> 00:42:09.213
I wish I went and got a law degree sometimes.

00:42:10.085 --> 00:42:11.431
Well, I feel like you've done enough.

00:42:11.431 --> 00:42:18.639
We've worked on enough LOIs that I can wholeheartedly say that you've got some savvy, some lawyer savvy in there for sure.

00:42:18.639 --> 00:42:28.518
Well, I wanted to ask as sort of a final question for you you know, what's a really great or favorite business book that you've read that you would recommend to a business owner?

00:42:28.518 --> 00:42:30.201
So tough and it could be in anything.

00:42:30.201 --> 00:42:32.612
It doesn't have to be acquisition based or exit planning.

00:42:33.313 --> 00:42:33.775
I read a lot.

00:42:33.775 --> 00:42:40.994
I'm always reading new books, nonfiction, business related but the one I read most recently I really enjoyed.

00:42:40.994 --> 00:42:44.971
It's called Richer Wiser Happier and essentially what it does it goes.

00:42:44.971 --> 00:42:59.657
It's an interview of, I think, like seven really famous investors A lot of them we've never heard of, and it talks about how there's so many different ways to make money and they just found their niche and they were laser focused on it and they stuck to it.

00:42:59.657 --> 00:43:03.516
And it may not be the cool, sexy things that everyone's doing with technology.

00:43:03.516 --> 00:43:13.556
You know, it kind of hit on the head like we are just going to stay in our lane and we're going to continue to do what we're doing and people might talk negatively about it and that's okay.

00:43:13.556 --> 00:43:21.007
You know, this is where our passion is and it kind of uh solidified that.

00:43:21.007 --> 00:43:25.507
It was written in a very fun way and they talk about now just you know, in the business sense but also in their personal lives how they, how they maintain both and they would stay happy, et cetera.

00:43:25.507 --> 00:43:27.592
It was very, very interesting read.

00:43:27.954 --> 00:43:28.596
No, that's cool.

00:43:28.596 --> 00:43:34.032
I I think that's probably one of the biggest questions for any business owner is how to balance it all.

00:43:35.813 --> 00:43:39.199
It's tough, I think, being a business owner I don't.

00:43:39.199 --> 00:43:40.501
It's really hard, I don't.

00:43:40.501 --> 00:43:43.313
I don't know how you do it and that's what.

00:43:43.313 --> 00:43:46.271
That's what makes entrepreneurship so fun and so stressful at the same time.

00:43:46.652 --> 00:43:49.606
Yes, absolutely Well, I appreciate you coming on the show today.

00:43:49.626 --> 00:43:50.347
Thank you so much for having me.

00:43:50.347 --> 00:43:52.128
Thank you so much, it was a lot of you.

00:43:54.211 --> 00:43:55.733
In the world of business.

00:43:55.733 --> 00:43:59.137
Not all deals are what they seem.

00:43:59.137 --> 00:44:13.507
Fortunes rise, empires crumble, all with the stroke of a pen.

00:44:13.507 --> 00:44:14.811
Mergers, acquisitions, hostile takeovers Welcome to Mergers.

00:44:14.811 --> 00:44:24.936
She Wrote where we examine strategies and stories behind the biggest deals in business, because in M&A, the real risks are the ones you don't take.